5 Dividends in Peril Right Now

Jonas Elmerraji|Contributor

Friday, 5 Oct 2012 | 11:04 AM ETThe Street

SHARES

Source: Progressive Auto Insurance

Progressive Auto Insurance

Be warned: Your dividend payouts could be in peril this quarter.

Make no mistake, it’s a great time to be a dividend investor. Corporate profits and dividend payouts are both making new all-time highs right now, and the dividend yield of the S&P 500 index is higher now than it’s been for the better part of two decades. But that doesn’t mean those income checks are safe.

With so many firms plowing mountains of cash to their investors, so too are a number of companies that can't really afford to. When those names cut their payouts, shareholders should at least be aware. After all, there are few things that can slam stock prices with such certainty as a dividend cut.

Normally, we focus on the other side of the dividends; typically, in this column, I point out companies that look primed to raise their dividends, not cut them. But figuring out which income names to avoid can often be just as beneficial for your portfolio as knowing which ones to buy. We’ve had a lot of success in pinpointing future gainers by focusing on a handful of metrics, so we'll flip them in reverse to spot potential dividend cuts.

For our purposes, that “crystal ball” is composed of a few factors: namely a leveraged balance sheet and a payout ratio that's high — in some cases higher than the earnings that firms actually brought in for the last couple of years. While those items don’t guarantee dividend cuts in the next month or three, they do dramatically increase the odds that management will need to cut payouts to avoid a more serious capital raise.

Without further ado, here’s a look at five stocks whose dividends are in peril in the next quarter.

Intuit

Tax season may be approaching, but TurboTax maker Intuit still looks likely to announce a dividend cut. That’s because while Intuit’s TurboTax product — and other titles like Quicken and QuickBooks — enjoy an impressive foothold in the accounting software market, they’re still facing a lot of competition from free alternatives and more hands-on services. That was enough to pressure shares to a bigger-than-expected quarterly loss for third-quarter 2012 and it makes a dividend cut look more likely.

Don’t get me wrong, there’s a lot to like about Intuit. The firm has more cash than debt, and it typically makes up for weak performance in the fiscal second quarter, when the lion’s share of tax season revenue hits the books. But growth isn’t there. The firm’s own free-tax-filing offering has been cannibalizing its premium TurboTax product, as have other free-filing options thanks to the relative ease of Americans’ tax returns after the recession.

With the market already saturated, organic growth doesn’t look promising in the tax prep business. While small business products do hold more growth prospects, Intuit faces a lot of competition from brick-and-mortar accountancy firms who cost more, but who offer more hand holding.

I don’t think that Intuit is going to feel a major cash crunch anytime soon (the firm should continue to generate around a billion dollars of free cash each year), but the firm has seen its cash fall to a lower level than has been seen in quite some time. For comparison’s sake, Intuit had twice as much of a cash cushion a year ago. The fact of the matter is that the firm’s dividend has been growing faster than its revenues have.

As the search for growth prospects burns through more cash, I’d expect the firm’s 1.16 percent dividend payouts to suffer.

Progressive

I don’t think that it’s a stretch to argue that Progressive is due for a dividend decrease. For Progressive, dividends aren’t set arbitrarily by management; instead, they’re calculated based on the firm’s financial performance. It’s a good approach because it ensures that shareholders (and management) get compensated in kind with the firm’s performance.

But income dropped 29 percent in the first quarter and another 52 percent in the second quarter, so a cut to the firm’s payout looks likely, even if the third quarter is showing early improvement.

Progressive is one of the four biggest auto insurers in the country, with more than 12 million policies and 35,000 independent agents in its network. Progressive is one of the best risk managers in the insurance industry, embracing new technologies like the firm’s Snapshot chips, which drivers can opt to plug into their cars’ computers to record driving patterns and determine better risk-adjusted rates. But as the insurance industry becomes more and more commoditized, the firm with the best price wins. And Progressive can’t compete with mutuals like State Farm and Liberty Mutual, who don’t care about profitability.

While Progressive should be lauded for its strong management, its risk aversion, and its scale, 2012’s financial performance simply hasn’t justified a bigger annual dividend at the end of the year. That’s why a cut to Progessive’s 40.72 cent annual payout looks likely. Currently, Progressive yields around 2 percent.

Windstream

Windstream shareholders are having a rough year in 2012. Shares of the $6 billion phone company have slid more than 12 percent since the start of the year, making their underperformance versus the broad market more than twice than that. And it could be worse if Windstream is forced to cut its dividend payouts in the next quarter or two.

Windstream is a phone company that serves more than 3 million phone lines and 1.3 million Internet subscribers. Even though the fixed-line business is a solid income generator, it’s also capital intense. Windstream’s recent acquisition spree hasn’t exactly helped ease the load on its balance sheet.

When investors talk about unsustainable dividends, Windstream’s 9.7 percent yield should serve as a good example. Currently, the firm pays out a quarterly 25 cents per share (or a full dollar per year), even though the firm has only earned 30 cents per share in income over the last four quarters. That’s not a new phenomenon — Windstream has been sporting a payout ratio higher than 100 percent for years.

With a balance sheet that’s already leveraged and its cash position dwindling, the firm is going to need some sort of a capital break to keep things running. A dividend cut looks like the “least bad” way to do that.

Harsco

There’s a similar situation brewing in shares of Harsco, a $1.68 billion industrial services firm. Harsco’s businesses include servicing metals and minerals miners, maintaining railroads, and engineering scaffolding. While that diversification is a plus for shareholders, it didn’t really help to lessen the blow that the whole industrial segment took during the Great Recession.

But in spite of sales and earnings numbers that are still well short of the numbers that the company booked back in 2008, the firm has been steadily increasing its dividend payout. As a result, it has paid out $1.74 more per share in dividends over the last 12 months than it has actually earned, a pattern that’s only sustainable for so long.

Even though Harsco has decent balance sheet liquidity, it also carries far more debt. Just like Windstream, something has to give eventually. Either Harsco drops its dividend, or it goes looking for capital in another, more painful, way.

Typically, utility stocks are a bastion of safety for dividend investors: Their payouts are big, they’re predictable, and their businesses are legal monopolies. But when a dividend balloons out of size, a dividend cut looks like the more likely scenario. That’s what’s going on at Pepco Holdings, a $4.3 billion utility company.

Pepco owns three regulated utility firms, Pepco in the Washington D.C., region, Delmarva Power & Light along the shores of Maryland and Delaware, and Atlantic City Electric in New Jersey. The firm has been holding a yard sale, offloading most of its generation assets, and focusing its business on regulated power retailing. While that does help make the firm’s earnings more stable, it doesn’t change the fact that Pepco’s payouts are oversized right now.

That’s because the firm is paying out more than it earns at the same time that it’s planning to dump a ton of cash into its power infrastructure. With most of the proceeds from the sales of power plants going to pay down debt (a good thing, no doubt), Pepco can’t keep paying out a hefty 5.7 percent dividend yield. A cut seems like the most likely outcome, especially with the firm’s operations under the watchful eyes of regulators in a handful of jurisdictions.